stock market & market indices

PowerPoint

to accompany

Stock Market & Market Indices

Copyright © 2011 Pearson Australia (a division of Pearson Australia Group Ltd) –9781442502000 / Berk/DeMarzo/Harford / Fundamentals of Corporate Finance / 1st edition

Types of Markets

Stock Exchanges

Trading of stocks listed in an exchange

OTC Trading

Trading ‘over the counter’ or outside a stock exchange, in dealer networks

ECNsElectronic Communication Network is an electronic system that allows order execution between exchanges and dealer networks


Trading Mechanics

Types of orders

Short selling

Buying on the margin


Types of orders

Instructions from investors to brokers

Market order

buy/sell order to be executed at best price

-- get lowest price for buy order

-- get highest price for sell order

market orders given priority in trading

no guarantee of execution price


Types of orders

Limit order

buy/sell order where investor specifies price range

“buy at $50 or less”

“sell at $52 or more”

investor sets reservation price but no guarantee that limit order will be executed


Types of orders

Stop order

order lies dormant

turns into market order when certain price (“the stop”) is reached

“buy if price rises to $60”

“sell if price falls to $58”

investor does not have to watch market but in a volatile market stop could be triggered prematurely


Types of orders

Stop limit order

Turns into limit order when stop is reached

“buy if price rises to $60, but only is executed at $65 or less”

“sell if price falls to $58, but only is executed at $55 or more”


How long is an order good?

IOC (Immediate or Kill)

FOK (Fill or Kill)

Day (Only on current day)

GTD (Good till Date)

GTT (Good till Time)

GTC (Good till Cancelled)

OPG (participate in Opening Auction only)


Order Size

Round lots

lots of 100 shares

Odd lots

less than 100 shares

more difficult to trade

Block trades

10,000 shares or $200,000 value


Short Selling

Sale of borrowed stock

Profit from belief that stock price is too high and will fall soon

borrow stock through broker

sell stock

buy and return later

Short selling could further destabilize falling prices


Short Selling

Short sales allowed if

uptick or zero uptick in price for previous trades:

$20, $21 (uptick)

$20, $20, $21 (zero uptick)

$21, $20 (downtick)



Buyer borrows part of purchase price of stock, using stock as collateral

borrow at call money rate/PLR

SEC sets initial margin requirement

Currently 50% of stock holding



If stock price falls

collateral worth less

if collateral worth only 125% of loan (maintenance margin)

-- margin call

-- owner must put up more cash or sell stock

margin calls can worsen stock crash



Problem: 1000 shares, $20 per share out of which 50% is

bought on margin

Leverage

gains/losses on $20,000 capital

but tied up only $10,000 capital

If prices falls to $12 the value of stock is $12,000. This is below 125% of $10,000 loan. Therefore we will get a margin call


Stock market indicators

Measure average performance of a group of stocks

The group of stocks can include the entire market or an entire sector or a selection of stocks based on some criteria


Stock Exchange index

Includes all stocks listed on exchange

NYSE CompositeAll stocks listed in the New York Stock Exchange

Nasdaq CompositeAll stocks listed in the Nasdaq Stock Exchange

ASPIAll stocks listed in the Colombo Stock Exchange


Subjectively selected index

Organization picks group of stocks according to various criteria

Dow Jones Industrial average30 largest industrial stocks in U.S. that are generally the leaders in their industry.

S&P 500500 largest stocks based on market capitalization in the U.S. stock market

S&P SL 2020 largest stocks based on market capitalization in the Colombo Stock Exchange